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Who’s Afraid of a Bank Tax?

By David Leonhardt April 27, 2010 5:26 pmApril 27, 2010 5:26 pm

You won’t be surprised to learn that Wall Street doesn’t like the idea of a bank tax. Wall Street lobbyists argue that a tax on banks — meant to discourage risky investments and cover the costs of financial crises — will keep banks from being able to lend to worthy borrowers. That’s not theoretically impossible, but it doesn’t seem very likely. The taxes under discussion would have a low rate. It’s also worth remembering that Wall Street’s lobbyists often claim that they are just looking out for the interests of borrowers.

A more surprising bit of opposition comes from regulators in Canada and Australia. Those countries survived the bust better than most, in part because of tougher oversight of their financial sectors. Now, with the International Monetary Fund suggesting a globally coordinated bank tax, Canadian and Australian officials are saying that their banks shouldn’t be punished alongside American and European banks.

Here’s how The Globe and Mail, a Canadian newspaper, summarized the view of Jim Flaherty, Canada’s finance minister: “the government does not want to see financial institutions in this country penalized because of their relative success and their stability during the course of the crisis.”

Canadian regulators prefer forcing banks to hold something called contingent capital. Under a contingent-capital system, banks would borrow money from investors with the understanding that the money would be converted into stock during a crisis. In effect, the money would help the banks survive a bust. They would not have to repay it to the lenders (or their government rescuers would not have to repay it), as is the case with a lot of normal debt. The lenders would instead receive an ownership stake in the bank.

Requiring contingent capital is a fine way to reduce the odds of taxpayers being on the hook for future financial crises. But it does not seem to be the magic bullet that some of its supporters are suggesting. How can we be sure banks will issue enough contingent capital to survive a bust? How do we know they won’t find clever ways around the contingent-capital rules?

The virtue of a bank tax is that it assumes history will repeat itself and that Washington won’t manage to keep up with Wall Street. A bank tax assures that Wall Street will help pay the costs of a future crisis.

And what about those Canadian and Australian banks? They may have done a good job of avoiding the worst of this crisis, but that doesn’t mean they always will. “If financial history teaches us anything,” as Carlo Cottarelli of the I.M.F. recently wrote, “it is that no one should think themselves immune from failures and crisis.” I’d also argue that the case for a bank tax in this country is stronger than in Canada, given our history of lighter regulation.

So if the United States and Europe decide a bank tax is in their best interests, they do not need to be dissuaded by Canada and Australia. No matter what, we can be confident that the world’s banks won’t all move to Toronto and Sydney.

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